Times are brutally tough for SMEs in Australia.
Ever since the Royal Commission into Misconduct in the Financial Services Industry tabled its report, bank financing has all but dried up.
This situation has put small business owners in a difficult spot; without access to credit, companies put expansion plans on hold. When gaps in cash flow arise, they might not be able to pay their rent or their employees. Livelihoods are put at risk.
As banks have withdrawn their capital, though, private lenders have stepped up to the plate. Australian business owners now have access to 20+ unsecured business loan providers, giving them options they didn't have a generation ago.
With tightened lending standards and trust with the public shattered, are the big banks in permanent decline? Are private lenders here to stay? Or will the Big Four reclaim their place in due time? In this report, we'll examine the present state of SME lending in Australia.
The Big Four have overreacted to the findings of the Royal Commission
The last 18 months in Australia's financial sector has not lacked for drama.
From December 2017 to February 2019, the Royal Commission has aired the Big Four's dirty laundry in full view of the public. Week after week, its hearings subjected us to sordid tales of corporate greed.
Financial planners forged documents to make risky investments without client permission. They failed to report thousands of transactions related to money laundering, criminal syndicates, and terrorist organisations. Loan applications made it absurdly easy for middle-class borrowers to obtain massive mortgages.
These revelations shocked everyday people... and they just kept on coming.
Although the Royal Commission didn't table its final report until February 2019, the writing was on the wall.
In 2018, as public trust began to erode, the Big Four took dramatic action. One of their most significant moves: overhauling simplistic home/business loan applications. For instance, ANZ Bank now requires extensive proof of income, expenses, and creditworthiness.
On top of that, they've also tightened how they determine borrowing capacity. Until last year, households making $150,000 per year could qualify for an $817,000 mortgage. A benchmark called basic living expenses, which estimated an annual outgo of $32,500 across ALL income brackets, made this possible. Over the past decade, it has permitted the issuance of oversized loans to borrowers who could barely afford them.
Banks like ANZ are now using the "lavish living expenses" benchmark to pre-approve mortgages. Under this measure, $150,000 households only qualify for a loan of $538,000. This example alone reveals a drastic 34% contraction in available credit.
The banks have also applied these same measures to small business lending. A similar credit squeeze has transpired, worsening what Australia's trading community has described as "recessionary" conditions.
Needless to say, things are looking grim. Small enterprises comprise 97.4% of all businesses in Australia. Unlike big multinationals, who boast billions in liquid holdings, these companies have much shallower pockets. All it takes is a significant economic downturn to put many operations in financial jeopardy.
This scenario is now unfolding before our eyes. As Australia's housing market has tanked, consumer sentiment has tumbled along with it. In March 2019, retail trade sank to 39.9 on the Performance of Services Index. This figure is well below 50, the equilibrium between expansion and contraction.
It's in this environment the banks have tightened not just home loan lending, but small business lending as well. To save face, they're turning away all but their best customers - the rest have been left to fend for themselves. As you'll learn later, this has created immense opportunities for private lenders nationwide.
The property bear market has dried up the market for secured loans
Tightened lending in the wake of the Royal Commission's findings isn't the only headache plaguing business owners. The downfall of the Australian housing market has also made it tougher to acquire funding.
Most loans issued by the Big Four are secured. To obtain them, you must have some form of collateral to "secure" the amount borrowed. Collateral can take many forms - from vehicles to valuables, any item a lender can quickly liquidate will do.
However, few people own cars or jewellery worth hundreds of thousands of dollars. Many Australians do, however, own property. As the Australian housing market surged, using equity to get secured loans was an easy and common practice.
Sadly, plunging prices have put a stop to that. According to analysis performed by Trading Economics, Australian housing prices sank 7.4 per cent year on year in Q1 2019. What's more, analysts believe the rout will get worse. Prices fell 3 per cent quarter on quarter in Q1 2019, up from a loss of 2.4 per cent quarter on quarter in Q4 2018.
The banks are in no mood to accept home equity as collateral, as it is evaporating before our eyes. With bankers saying "no" when they've always said "yes", small business owners are scrambling for alternative financing.
Small business owners have turned to private lenders for funding
Had this crisis happened 20 years ago, Australia would already be in the throes of a severe recession. But thanks to the Internet businesses that would have collapsed have been able to stay afloat.
Since its founding, the World Wide Web has provided a low-cost environment that has allowed startups to flourish. As such, non-bank loan providers popped up like mushrooms in the 2010s. As banks tightened their lending practices in 2018, interest in private lenders soared. According to Google Trends, search queries of "Prospa," a leading private lender, spiked in mid-2018.
Unlike the secured loans of the Big Four private lenders offer unsecured funding; you don't need to provide collateral to obtain an unsecured loan.
In most cases, a decent credit score, sales data, and proof of cash flow are all that's needed.
According to PricewaterhouseCoopers Australia, the pullback of the banks from SME financing has led to a private lending boom. According to their figures, non-bank loan providers collectively increased their market share to 27% in 2018.
But it appears the party is only just getting started.
Private loans are soaring...perhaps too quickly
The retreat of the Big Four from SME lending left many businesses without a source of capital.
Despite this, the numbers are shocking. By all appearances, a seismic shift in the small business financing market is underway. Non-bank real estate loans have increased 13 per cent year on year from 2017 to 2018. Overall, non-bank loans have increased 15 per cent year on year, while the market share of the Big Four has declined.
Let's look at a few examples of private lenders that have thrived in the past year.
Exhibit A: Bluestone.
In August 2018, they announced that loan applications had spiked 96 per cent year on year a near-doubling.
Exhibit B: Liberty Financial.
In FY18, they reported after-tax profits of $64 million, up 10 per cent from the previous year. This performance boost was driven by a 15 per cent increase in loans, and increasing managed assets by 35 per cent to $10.2 billion.
And what about Prospa, Australia's biggest private lender? In March, they passed a monumental milestone, surpassing the $1 billion mark in loans issued since their founding seven years ago. New loan originations are up 44 per cent over last year, and revenue jumped 41 per cent year on year to $67.7 million.
However, concerns are growing the industry might be overextending itself. In their Q4 2017 bulletin, the Reserve Bank of Australia disclosed its concerns about the meteoric rise of private lending: "On a large enough scale, it could damage financial system resilience," they said.
As the ledgers of private lenders balloon, the prospect of a Lehman-style collapse is certainly a worrying one.
Banks and the government are scrambling to regain the public's trust
Realising the damage done by Royal Commission regulations, banks and the Australian government have extended an olive branch to business owners and home buyers.
Contracts for loans under $3 million have been greatly simplified. Greater clarity on required documentation, wait times, and reasons for rejection have also been written into law. Finally, when banks decide to call in loans, mandatory notice periods have been established. When a bank declines a loan extension, the borrower now has 90 days to pay the balance.
The government has also eased some of the strictest home loan rules on the books. Just a few weeks ago, the Australian Prudential Regulation Authority, suspended the stress test. Previously, banks were required to determine whether a client could make mortgage payments at rates of seven per cent. Now, banks are free to establish their own tests.
Is ASIC wielding its newfound powers too liberally?
Another outcome of the Royal Commission: the Australian Securities and Investment Commission (ASIC) now wields new enforcement powers.
Previously, it had endeavoured to achieve compliance through arbitration. Now, it has the mandate to file lawsuits against players that are in clear violation of the rules.
ASIC's hawkish turn has raised ire among bankers and executives from Australia's Big Four. In particular, Westpac CEO Brian Hartzer lambasted ASIC for its "highly prescriptive" approach to financial regulation. If they proceed with implementing "responsible lending regulations" Kerry Stokes would have never gotten the loan needed to start his empire, Hartzer claimed.
ASIC has pushed back hard against these criticisms. While the Royal Commission proposed new responsible lending rules, they were intended to "provide clarity," and are not set in stone.
However, ASIC has not held back in the legal arena. Just this month, they filed a civil suit against ANZ for charging customers illegal fees on 1.3 million separate occasions.
The Big Four aren't going anywhere...but neither are private lenders
At the end of the day, Commonwealth Bank, ANZ, Westpac, and NAB will be fine. The vast majority of Australians hold accounts with these institutions. With all the fees they charge, it's no mystery how they earned $29 billion in profit last year.
However, the collective belt-tightening forced by the Royal Commission ensured one thing: Non-bank lenders aren't going anywhere. Small businesses are essential to our communities. If the big banks are unable to provide the capital they need to make payroll, private lenders will.
Given their growth over the past year, there's plenty of demand in the Australian business community for their services.
Business News Australia