5 Myths about Invoice Finance

5 Myths about Invoice Finance

Invoice finance has been around for about 4,000 years. Called Factoring or Invoice Discounting, it hadn’t changed much at all until recently.

But now with the global evolution of Confidential Invoice Trading, it is becoming a full-on 24/7 21st century engine of growth for those in the know. In the UK alone, over $2bn of trades have been completed and now it is growing at similar rates in Australia. However, many businesses are missing out on this simple and effective method of growth funding due to the myths that still exist around it.

Here are the top 5 invoice finance myths and how they compare to the facts.

Australia a nation of small and mid-sized businesses

Interesting analysis by Bernard Salt in The Australian - Australia a nation of small businesses

The Australian business community is like a pyramid with more than one million sole traders spread across the base and which continues to expand (excluding SMSFs). About 600,000 micro businesses are on the up and arguably deliver the best employment bang-for-buck when triggered into expansion mode. The bigger end of the small business spectrum (employing 5-19 employees) and the whole of the medium ­enterprise sector (20-199 employees) seems to be stagnating. And this would be of concern if the big business sector wasn’t expanding.
— http://www.theaustralian.com.au/business/opinion/bernard-salt-demographer

This highlights a common misunderstanding about mid-sized business growth drivers: there is an important constraint on growth in this segment. Our Basel III banking system makes it possible for major banks to leverage housing loans 40 times compared to less than 10 times for loans to businesses other than major corporates. As a result, business loans are highly unattractive for our banks. Instead, business banking is seen as a source of cheap deposits. EG UK banks have net deposits of £60bn from SMEs – data not disclosed in Australia but similar levels relatively.

The impact of this is quite fundamental. Most employers of 20-199 employees (1 in 4 jobs) cannot access sufficient working capital funding (ie overdrafts) to finance expansion. Most are services/knowledge-based businesses with no real estate security to offer to a bank. As a result, once micro and small businesses become successful, they get stuck badly.

We see this every week. Businesses with $10-30m of revenue and just $100-200k of overdraft, if they’re lucky. Taking on a new $1 million B2B contract with long payment terms is impossible as you need to find $200-300k just to fund long payment times for accounts receivable. Despite this, mid-sized businesses are adding jobs and we would argue this is the sector which can and will move the needle most on Jobs and Growth – with funding.

This is not the case overseas, particularly in the US and Europe where policy makers have recognised the need to provide incentives to business funders, including banks, and historically the market for business finance is deeper. Germany is the most obvious example where Middlestand businesses account for over 50% of the economy. More data here.

Fixing this problem should be a top priority for those in charge of our economy.

Note: For further analysis and potential solutions, have a look here.

We need to change direction - our housing credit bubble is leaving business behind

Interesting article by Christopher Joye in the AFR today - see below - calling out our policy makers for spurring on our consumer credit bubble. Businesses are left behind.

It really matters that credit should be available for business purposes to finance growth. But our system allows banks to leverage house loans 40 times compared to 'only' 10 times for an SME loan.

So small-medium sized businesses that employ must of us don't get a look in...unless they own some real estate of course.

BANK LENDING TO SMES IS IN LONG TERM DECLINE GLOBALLY AND IN AUSTRALIA – OUR BANKS HAVE TURNED INTO BUILDING SOCIETIES AND THIS IS HOLDING BACK OUR ECONOMY

Our banks only want to lend against houses. Since 2013, only 11% of new business lending in Australia has gone to small businesses with little growth:

  • Most of the $900bn of loans outstanding to businesses goes to the big end of town
  • $269bn lent to SMEs is swamped by over $1,500bn in residential mortgage lending
  • Banks see SMEs as a critical source of cheap deposits – SME deposits far outweigh SME loans
  • But SMEs employ the bulk of our workforce

Due to global regulatory capital rules (Basel III), mortgages are more than 3 times more profitable than SME loans:

  • Real estate carries a risk weighting of 25% but SME loans require 100% (75% if backed by real estate)
  • Banks have effectively withdrawn from their original purpose: facilitate commerce

Meanwhile SME growth and employment is constrained by lack of cashflow facilities:

  • Banks will only lend to SMEs with real estate security which is a problem in a service based economy
  • The ATO/taxpayer is forced to act as lender of last resort (ATO is owed $12.5bn in tax by SMEs and growing rapidly)
  • Tight cashflow holds back growth:

The RBA is blowing the mother of all bubbles

Can history be repeated? A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966". RICHARD DREW

Can history be repeated? A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966". RICHARD DREW

by Christopher Joye

With US employment growth again surprising forecasters and the jobless rate declining to a boom-time 4.7 per cent, below "full-employment", the question is whether central banks, and the Federal Reserve in particular, are "behind the curve".

In research this week Goldman Sachs assessed this using a framework previously advocated by Fed chair Janet Yellen. Goldman found "the Fed's current policy stance is about 1 percentage point easier than prescribed by a Taylor rule that uses a depressed neutral rate" and about 3 percentage points easier when adopting a more normal neutral cash rate of about 4 per cent. The latter assumption "implies that the current policy stance represents the largest dovish policy deviation since the 1970s", which coincided with an inflation break-out.

"The implication that current policy is somewhat 'too easy' is consistent with the fact the [US] financial conditions index remains easier than average and is still delivering a positive growth impulse at a time when the Fed is trying to impose deceleration," Goldmans said.

The investment bank warns "history counsels caution about falling behind" with the experience of the mid 1960s suggesting that inflation increases much more quickly at very low unemployment rates. Back then, years of benign inflation gave way to a sudden spike as the Fed wilted under political pressure not to aggressively tighten rates. A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966".

Federal Reserve Chair Janet Yellen: The third rate hike since the 2007-2009 recession was well telegraphed. Andrew Harnik

Could history repeat itself? Much hinges on policymakers' humility. Central bankers are not fond of acknowledging errors, often rationalising ex post facto via the meme that "this time is different", which can be exacerbated by the desire to propagate an image of infallibility. Remember the once-lionised monetary maven Alan Greenspan?

These risks have certainly spooked interest rate investors, although the adjustment process has a way to run. After the second biggest fall in fixed-rate (as opposed to floating-rate) bond prices in modern history in the December quarter, the spectre of a Fed hike in March - duly delivered this week - has lifted long-term rates further. 

Will RBA ever lift again?

In Australia the 10-year government bond yield is nearing 3 per cent, significantly higher than the sub-2 per cent level traders—gripped by "cheap money forever" fever—priced in September 2016. Current 10-year yields are, however, still miles below the 5.5 per cent average since the Reserve Bank of Australia started targeting inflation in 1993.

Some of the best interest rate traders I know, almost all of whom have never experienced a proper inflation cycle, genuinely believe the RBA "will never hike again".

The problem with a supercilious central bank is the ensuing risk insouciance increases the probability of mistakes. A classic example was a speech given by the RBA's new head of financial stability this week.

According to this revisionist narrative the global financial crisis (GFC) "hasn't fundamentally changed the way we think about financial system stability". The RBA is evidently so sensitive to allegations it has failed to heed the lessons of the GFC—by blowing the mother of all bubbles with excessively cheap money—that it felt compelled to repeat the mantra the crisis had not altered its approach on five separate occasions in the speech. There are demonstrable flaws in this fiction.

First, the RBA never came close to anticipating the GFC. Its financial stability guru, Luci Ellis, published a paper in 2006 arguing"the most important lesson to draw from recent international experience is that a run-up in housing prices and debt need not be dangerous for the macroeconomy, was probably inevitable, and might even be desirable".

Ellis maintained that "the experience of Australia and the UK seems to suggest booms in housing price growth can subside without themselves bringing about a macroeconomic downturn". Two years later the 33 per cent drop in US house prices would trigger the deepest global recession since the great depression.

Second, the GFC necessitated a raft of policy responses that had never been seriously contemplated before, which have transformed the way we think about dealing with shocks and the unanticipated consequences. Contrary to the recommendations of the 1997 financial system inquiry, the Commonwealth guaranteed bank deposits and bank bonds for the first time. The RBA agreed to buy securitised mortgage-backed portfolios via its liquidity facilities, which it had never done, and Treasury independently acquired $16 billion of these loans in the first case of local "quantitative easing".

Banks borrowed more money on longer terms from the RBA than anyone previously envisioned, which led the RBA to create a new bail-out program called the committed liquidity facility. In emergencies banks can now tap over $200 billion of cash instantly at a cost of just 1.9 per cent that makes trading while insolvent an impossibility.

A central tenet of pre-GFC regulation--attributable to the 1997 Wallis Inquiry—was that taxpayers should never guarantee any private firm for fear of inducing "moral hazard". This is the "heads bankers win, tails taxpayers lose" dysfunction that emerges when governments insure downside risk. The RBA has since conceded that the crisis bail-outs unleashed unprecedented moral hazards, such as too-big-to-fail institutions, that require new mitigants.

The Australian Prudential Regulation Authority used to allow the major banks to leverage their equity 65 times when lending against housing because these assets were presumed to be nearly risk-free. Since the 2014 financial system inquiry APRA has been persuaded to deleverage the major banks' home loan books to merely (!) 40 times.

In 2013 the RBA was publicly dismissive of foreign regulators' efforts to contain credit growth via so-called macroprudential interventions to cool hot housing markets. One and a half years later APRA belatedly sought to cauterise the housing boom the RBA's 2012 and 2013 rate cuts precipitated with light-touch macroprudential jaw-boning.

Of course in 2017 the RBA has a different version of events. Apparently it has always seen "macroprudential policy as part and parcel of the financial stability framework". It turns out that "in 2014 the Australian regulators [presciently!] took the [rear-]view that risks were building in the residential housing market that warranted attention".

Actually, none of APRA's December 2014 announcements had any impact until well into 2015 (two years after the boom started) and they proved to be woefully inadequate. This column revealed, for example, that many banks had completely ignored APRA's minimum serviceability tests on home loans.

Good risk management requires intellectual honesty, which is missing in action among those overseeing the "wonder down under".


Read more: http://www.afr.com/personal-finance/the-rba-is-blowing-the-mother-of-all-bubbles-20170316-gv043y?&utm_source=social&utm_medium=twitter&utm_campaign=nc&eid=socialn:twi-14omn0055-optim-nnn:nonpaid-27/06/2014-social_traffic-all-organicpost-nnn-afr-o&campaign_code=nocode&promote_channel=social_twitter#ixzz4bXWSWyAu 
 

Harvard report - SMEs "cut back on hiring even in the presence of customer demand" due to lack of finance!

An amazing ‘discovery’: economists are beginning to figure out that cashflow constraints hold back SMEs from growing their businesses!

…financing frictions can have a consequential effect on employment when firms face a constraint on working capital (Jermann and Quadrini 2012). This is particularly true among small or young firms that are in growth mode, as the mismatch between the timing of cash flow generation and payments to labor requires firms to finance their payroll through the production process - in advance of getting paid - and means that firms may have to cut back on hiring even in the presence of customer demand and adequate labor supply, due to an inability to pay workers in advance of receiving cash for their product or service.

Survey evidence indeed suggests that over 90% of small businesses pay their employees twice a month or more frequently, with nearly half paying their employees weekly (Dennis 2006).

In the presence of financing frictions, even small improvements in cash collection can have large direct effects on hiring due to the multiplier effect of working capital. To see why, note that a firm with $1 million of sales being paid 30 days after delivering its product always has $80,000 of cash ‘tied up’ in receivables at any moment in time. A shift in the payment regime from 30 days to 15 days therefore permanently unlocks $40,000 of cash for the firm on an ongoing basis. In the extreme where the firm was only able to support growth through internal cash flow, this will allow the firm to double in size, to $2 million, showing how seemingly small improvements in the working capital position for constrained firms can have consequential effects for growth in sales and in payroll.

Here is a link to the report: Can Paying Firms Quicker Affect Aggregate Employment? 

The Trump Tsunami will hit Australian Business Finance

The Trump Tsunami will hit Australian Business Finance

As the world comes to terms with the shock election of Donald Trump as US President, we believe that financing Australian businesses is likely to become more challenging with knock-on consequences for our next election.

In the mid-market alone, we estimate that up to $15 billion in working capital finance could be required every year to catapult our most dynamic businesses forward. With annual revenue of $5 million to $250 million and 50 to 500 employees, they are the engine room of our economy. But the Trump Tsunami is about to make things harder.

Financing your growth - bank computer says no

Financing your growth - bank computer says no

Traditionally, the first port of call for a business owner is his bank. There needs to be a clearer understanding about what banks are incentivised to do these days. They are not interested in unsecured lending to SME businesses - overdrafts, working capital, etc. Regulatory capital weightings penalise banks for lending on anything but real estate by a factor of about 4x. That's before even considering the high staff costs involved in making and monitoring credit decisions involving non-real estate collateral. Too hard. This is why credit cards are the main source of working capital for SMEs today but try getting a $200k limit!

Don't Bank on it! Tips on financing business growth

Established businesses that are expanding rapidly face challenges from all sides. They may be winning large contracts with slow-paying major customers, recruiting at a fast pace, experiencing increased competition and market pressures, they may need to invest in production, marketing and development almost simultaneously and the management team may also be looking at new ventures and territories.

If this sounds like you, then you will be familiar with the sensation of having to keep all the plates spinning, while also professionalising your business – perhaps taking on greater financial or managerial clout. You might be recruiting at director-level, while also cementing existing relationships with everyone from new recruits to your oldest customers.

As a thriving, established business, you have already established your credentials but to maintain growth, the business requires more working capital investment.

Most growing mid-sized businesses with revenue of $10-30 million could really do with another $1 million to fund growth. But where do you find it?

Raising equity from business angels does not make sense for most established businesses. Few owners are happy to give up control of their business. Similarly, few businesses fit the criteria of business angels who look for unique companies with strong growth potential and solid prospects for a sale of the business in the medium term.

At the other end of the spectrum is your bank. Unfortunately, banks require real estate security so it will be impossible to obtain meaningful working capital finance from a bank without pledging a substantial amount of real estate. Business owners waste a lot of valuable time looking for an overdraft from their bank.

Filling the void, peer-to-peer business loans can provide an alternative source of finance. These sources of funding are thriving but are typically only able to provide up to $150k on an unsecured basis. The costs are quite high and the need to repay monthly over a 6 month term makes even less sense for growing businesses.

However, there is another key option: your existing sales ledger can also provide a valuable source of cashflow with larger facility sizes ($1m+) than available from unsecured lenders.

Historically, the only option was factoring which involves onerous contracts and the consent of your customers. An ancient model, literally as it was invented around 4,000 years ago in Mesopotamia, it doesn't work for most businesses.

Now there is a much better way - confidential invoice trading. Online invoice trading platforms connect businesses with a pool of investors who will advance funds against existing valid invoices. Instead of waiting out long payment periods, businesses trade their invoices and receive a percentage of their value – around 80% - with a minimal waiting time. All without involving your customers.

Online or alternative invoice finance improves on the traditional approach to invoice finance and factoring considerably.

It is possible to trade a single invoice, rather than surrendering a complete sales ledger to a provider. The technology platform keeps costs low, and decisions on creditworthiness are rapid. Generally, platforms approve businesses within a day, provided they can produce bank statements and accounts. Once invoices are validated funds can be made available straightaway. Costs come in at around one to three per cent, but over time this kind of finance becomes more cost-effective, with discounts for subsequent invoices.

Invoice finance is a useful means of improving cash flow and unlocking access to working capital. It is also particularly helpful for businesses considering export markets where payment cycles can be unpredictable particularly in the short term.

Check out the alternatives to banks. Speak to a finance broker or your accountant or enquire directly with providers that seem to fit your needs.

Why a lack of working capital stops growth dead in its track

Mid-sized businesses, turning over $5 million to $250 million annually with 50 to 500 employees, are the engine room of our economy. They provide 1 in 4 jobs in Australia and represent our best chance of achieving the Government's Jobs and Growth objectives.

"With a combined annual turnover of around $1.1 trillion, if Australia’s mid-size businesses were a state, their economy would be larger than Queensland" according to Greg Keith, CEO of advisory firm Grant Thornton in releasing their Australian Mid-Sized Business Report 2015.

Our banking system cannot provide businesses with pure working capital funding as they require real estate security as collateral.

The numbers are large. A sector with $1.1 trillion of annual turnover and an average of 51 days of outstanding accounts receivable has $154 billion tied up in outstanding invoices most of the time. To grow revenues at say 10% per annum, the sector needs to find over $15 billion in working capital finance every year.

Where to do you find this without real estate security? In a service-led economy, we need to fix this problem to create Jobs and Growth.

How our Government missed the opportunity to fix our dysfunctional business banking system

In the UK, P2P lending to business has developed rapidly with support from the British Business Bank, set up in 2013 by the UK Government. It has a mandate to facilitate up to $20bn of SME finance by 2019. Whilst bank lending to London’s SMEs plummeted 40% in 2015, the UK capital’s companies raised an estimated £350m through peer-to-peer lending in the same year, according to the British Bankers Association.   

In the US, the Small Business Administration has guaranteed over $112bn of loans with a bad debt rate of less than 1%. In 2015 alone, $24bn was advanced.

Credit guarantee schemes work. They overcome the clear risk aversion that affects our banking system when it comes to business loans by limiting the apparent downside. And taxpayers' money is put to work for a good return.

Over the last 3 years to June 2016, our banks have increased their housing related mortgage books from $1,178 billion to $1,472 billion according to the RBA and APRA. That's another $294 billion dropped into non-productive, dead assets.

Meanwhile, small business lending has increased by a miserable $26 billion, an annual rate of just 3.4%, to $269 billion over the same 3 year period - not 13-15% pa as stated recently by ANZ's Shayne Elliott.

Since 2013, only 11% of new business lending has gone to small businesses. Most of the $900 billion of loans outstanding to businesses goes to the big end of town.

However, the Productivity Commission finalised a report on Business Set-up, Transfer and Closure in December 2015 which carries a serious amount of weight in Canberra.  It concluded that there was no problem in accessing business finance in Australia despite submissions to the contrary by many reputable bodies.

Unfortunately, many of its conclusions were unhelpful for SMEs because of the required focus on starting and exiting businesses - their mandate ignored the obstacles faced by growing businesses. As a result, mid-sized businesses, the engine room of our economy, were not even considered: they provide 1 in 4 jobs in Australia and represent our best chance of achieving the Government's Jobs and Growth objectives.

"With a combined annual turnover of around $1.1 trillion, if Australia’s mid-size businesses were a state, their economy would be larger than Queensland" according to Greg Keith, CEO of advisory firm Grant Thornton in releasing their Australian Mid-Sized Business Report 2015.

Recent announcements by Greg Hunt,Federal Minister of Industry, Innovation and Science, show that the message may be sinking in slowly despite the nay-sayers. He acknowledged that "As companies grow from $20 million to $200 million in value, there is often real difficulty in finding investment capital". However, this ignores the fundamental working capital funding gap - growth requires working capital as well as capital investment.

Credit guarantee schemes have been very successful overseas but the few dated studies reviewed by the Productivity Commission led to the wrong conclusion. To see what it is missing, our Government needs to study carefully the powerful positive effects of setting up the likes of the British Business Bank in the UK, the Small Business Administration in the US and the European Investment Fund in the EU.

Government funds should be invested alongside private sector funds to fix a clear market failure to finance the growth of established Australian businesses. The most effective way to do this is set up one well-equipped agency to make it happen across Australia. 

Here is the relevant extract from Productivity Commission report:

Is there a role for a credit guarantee scheme?

Credit guarantee schemes (CGSs) can be structured in a number of ways, although most take the form of a public scheme whereby creditors are paid part or all of the value of defaulted loans made to businesses out of government budgets. In return, the government receives part of the return on a performing loan. CGSs are common internationally, although Australia does not have such a national scheme. 

ACCI (sub. 11), while noting the potential problems with a CGS, proposed that the Government should consider implementing a scheme in Australia:

The Government should explore the feasibility of a temporary small business loan guarantee scheme. Similar schemes operate in several other international jurisdictions, including the US, UK and Canada, with varying levels of eligibility and coverage. Such a scheme could suffer from ‘moral hazard’ issues. Further, it could impose contingent liabilities on the Commonwealth’s balance sheet. However, a well designed scheme would avoid the pitfalls associated with any risk sharing financial scheme by establishing rigorous eligibility criteria and assessment guidelines. If implemented, the scheme could have a sunset provision, preceded by a review date. (p. 15)

In their post draft submission, the Chamber of Commerce and Industry Queensland also endorsed a role for government in underwriting businesses access to finance (sub. DR44). The issue of credit guarantee schemes has also received attention in a number of recent reports. For example, it has recently been advocated by Deloitte Access Economics (2013a): 

Well designed and managed [credit guarantee] schemes can limit the call on public finances. If information asymmetry causes the potential lender to attribute a higher risk of default to a borrower in the absence of adequate security, the credit guarantee can address this. By reducing the loss given default with a guarantee, the CGS increases the likelihood of viable businesses gaining access to finance. (p. 30)

The Institute of Public Accountants also supported the introduction of a CGS in their Australian Small Business White Paper (2015): 

To increase the availability of much needed affordable loan finance to the small business sector, the Federal Government should introduce a state backed loan guarantee scheme. The scheme would provide a limited State backed guarantee to encourage banks and other commercial lenders to increase loan finance available to smaller and younger start up firms that face difficulty financing new investment opportunities through normal commercial channels. (p. 27)

Those in favour of CGS argue that it would improve lending to new or small businesses by:

  • reducing the effects of information asymmetries on bank lending decisions, given that banks will be more willing to lend to new and small businesses if they know that part of their investment is covered in the case of default
  • reducing the need for business owners to provide collateral to secure a bank loan
  • reducing the risk weight attached to small and medium sized enterprise business loans under the Basel III framework — this in turn reduces the amount of capital banks need to hold to against these loans, which may encourage additional lending (Deloitte Access Economics 2013a). 

These factors are often argued to have positive flow on effects on employment or economic growth, although the cost to the community of achieving any such effects is not usually considered. Advocates also note that Australia is one of the few developed countries that does not operate a CGS. 

Arguments against the introduction of a CGS include that:

  • It simply involves a transference of risk from private lending institutions to taxpayers. Further, it may dissuade lending institutions from undertaking sufficient vetting and monitoring processes when making loans, increasing adverse selection and moral hazard problems. In other words, a CGS can reduce a lender’s loss in the event of default, but does not reduce the probability of default (and could actually increase it if banks are discouraged from undertaking adequate vetting and monitoring). 
  • There is little conclusive evidence that a CGS results in more business loans being made (box 7.5). In other words, there is not clear additionality or incrementality from introducing a CGS. 
  • The costs of setting up and maintaining a CGS are high. They also represent a significant contingent liability on the public budget that can become large very quickly should many loans default (as might be the case in a severe recession for example).
  • Despite not having a CGS, Australia’s entry rate for new businesses is higher or comparable to many countries that do — for example, Canada, Italy, Spain and the United States. Further information about how Australia’s entry rate compares with other economies can be found in chapter 2.

Box 7.5    Studies on credit guarantee schemes

The effectiveness or otherwise of CGS in increasing the ease of access to debt finance is a subject of much debate within the existing empirical literature. Several studies identify positive effects. For example:

  • Craig, Jackson and Thomson (2005) found a statistically significant but small relationship between the level of guaranteed lending under the United States CGS in a local banking market and future per capita income growth in that market.

  • Riding, Madill and Haines Jr. (2007) found that the Canadian CGS facilitates lending to SMEs that would not otherwise qualify for loans, with this having flow on effects to job creation.

  • Zecchini and Ventura (2009) found the Italian CGS has been effective in reducing the borrowing costs of SMEs and easing their financing constraints. 

  • Uesugi, Kaki and Yamashiro (2006) found that the Japanese CGS increased credit allocation to businesses that used the scheme. 

However, Green (2003) and O’Bryan III (2010) concluded that it is difficult to prove that CGS do contribute to additional lending to small businesses while De Rugy (2007) suggested that the rate of business start ups in the US would be the same both under and without the 7(a) CGS in the US. 

Empirical work examining the effects of CGS on business survivability is also inconclusive — for example, Oh et al.(2008) found that businesses supported under the Korean CGS did experience significantly higher survival rates, however this contrasts to research by Uesugi, Sakai and Yamashiro (2010) that found that participants in the Japanese scheme were significantly more likely to experience financial distress than businesses that did not take part.

Studies have also examined whether CGS distorts the credit market — for example, Cowan, Drexler and Alvaro (2012) find that CGS reduces the effort exerted by banks in collecting loans, which has marked effects on the proportion of loans considered to be delinquent (behind in repayments by more than 60 days). As CGS typically see defaulted loans repaid at least in part by governments, the cost of these delinquent loans is partially borne by taxpayers. Green (2003) suggests that schemes available for loans made to small businesses may see an undesirable substitution of credit away from large (uncovered) borrowers towards small (insured) borrowers. The possibility of distortions is also acknowledged by Honohan (2010) who notes:

Even if fiscal costs are low, the economic costs of misallocated resources can be high. While it is clear that public interventions into the credit market will tend to have distorting incentive effects, these distortions are subtly different depending on the type of scheme, for example, resulting in too much entry, too much risk, too little monitoring or entrepreneurial effort or in rent seeking behaviour. (pp. 6–7)


Setting the optimal price of a CGS is also problematic for governments. If the price is too high, the scheme is likely to be weighed down by adverse selection and moral hazard problems as only high risk applicants self select into the scheme (lower risk borrowers seek finance elsewhere). Too low a price and there will be a tendency for lower risk businesses (that are capable of sourcing finance outside of the scheme) to select into the scheme. In this case, government has taken on a credit risk and an actual and contingent cost with no additionality in business lending (OECD 2013d). A further complication is the fact that the optimal price that strikes a balance between these outcomes is subject to constant change depending on the interest rates, ease of credit access and overall conditions of the wider economy.

The Commission examined public guarantee schemes in 2014 as part of its inquiry into public infrastructure and noted that such schemes place contingent liabilities on government balance sheets (that then puts pressure on credit ratings), act as a source of moral hazard risk, distort financing decisions and are often not transparent (PC 2014a). 

In relation to its current inquiry, the lack of systemic financing problems for new businesses substantially weakens the case that Australia needs a CGS. Furthermore, as discussed above, CGS are distortive and inefficient, they transfer risk from private parties to taxpayers, and may adversely affect the vetting and monitoring behaviour of lenders. Whether CGS materially increase either the amount of loans for new businesses (that is, delivers additionality) or business survival rates is also disputed in a number of studies. For these reasons, the Commission recommends that CGS not be pursued by Australian governments. 


RECOMMENDATION 7.2

Australian governments should not pursue credit guarantee schemes as a means of enhancing the ability of new businesses to access debt finance. 


 

 

 

The hidden cost of applying for credit

Insights from the CPA's recent SME Finance roundtable in Melbourne

Recently, in a packed room of CPA members in Melbourne, I had the pleasure of participating as part of a panel discussion on the exciting changes sweeping the market for mid-market finance, and how new forms of finance are powering this engine room of our economy.

With over 50 different new online lenders, this new breed of financier are providing everything from quick turn-around loans to working capital finance and equipment finance, and branded as everything from ‘FinTech’ to ‘marketplace’ or ‘peer-to-peer’ lenders. The question on everyone’s lips as they arrived was ‘what do they have to offer to mid-sized businesses?’ 

What we easily agreed was that where online lenders really excel for the mid-market is in their ability to finance unconventional products in unconventional ways. For example, in providing confidential invoice trading facilities, InvoiceX is able to finance accounts receivable on an invoice-by-invoice basis, allowing clients to control their financing costs in real time. As a result, mid-market companies can avoid signing up to onerous contracts associated with invoice factoring where you would typically sign over all of your accounts receivable on a disclosed basis for a year or more.

However, as all of the participants quickly realised, even though the financing process is conducted through the internet more quickly and easily and leverages different forms of security and collateralisation than conventional lending, traditional barriers to access still remain – including the dreaded ‘credit check.’

But this credit check doesn’t need to be dreaded – with a couple of simple steps, you can avoid creating a negative credit picture with the credit bureaux. 

Under the Comprehensive Credit Reporting (CCR) reforms introduced in 2014, banks and other lenders are supposed to share positive credit data, but progress and uptake of positive reporting has been very slow. That’s a pity because it would give a fuller and fairer picture of the credit applicant’s financial health, enabling a positive assessment for good recent credit performance (for example no missed payments in the last 24 months) rather than potentially being denied credit because of a low-value default many years ago. As it stands today, only negative data is available.

It is not widely appreciated that shopping for credit can lead to what is referred to as a high ‘inquiry pattern’ by the credit bureaux. This can have a more detrimental impact on your credit score than their paying more than half of your accounts payable between 1-30 days late. 

Fortunately, through speaking with your advisors, you can ensure you’re avoiding this problem by selecting the right credit provider before applying. By engaging them early in the credit application process to build an accurate credit picture and approaching the most appropriate providers for a decision in principle before formally applying for finance, you can minimise the resultant hit to your credit score. 

With these easy steps you can protect your credit score and over the longer term improve it to access cheaper sources of finance.

Go on, have a chat with your advisor today and get your credit score lean and ready for summer business.

The dangers of not paying the ATO on time

Recently, an accountant commented on social media that borrowing from the ATO at 9.1% is a good deal. This struck us as a very risky approach to business finance.

The ATO is different to other creditors. The ATO has the right to demand tax debt and take money from you without proving its debt in court. It also has the power to demand and take security deposits for future debts even before they exist. They can turn a company tax debt into the director’s personal liability and take the director’s house. The tax office is a very powerful creditor that demands careful handling and negotiation.

During the 2015 financial year, the amount due to the ATO totalled approximately $34 billion, of which some $26 billion was 90 days or more overdue, up $2 billion on FY14. It is estimated that 60% relates to SMEs. So it is a widespread problem for Australian businesses and the ATO is being much more pro-active in tackling arrears.

The ATO will, on occasion, allow directors to negotiate a payment arrangement allowing the ATO debt to be repaid in smaller amounts without interest or penalties over time.

However, you should be very careful in agreeing a payment arrangement as:

  • 50% of payment arrangements entered into with the ATO end in default
  • Directors can be made liable at any time for unpaid tax if their company defaults and
  • Once an arrangement has been negotiated, it must be adhered to

Sometimes, the better solution is to restructure your business or look at finance options to clear the arrears and fix underlying working capital issues. Growth inevitably leads to cashflow pressures so finding a solution is critically important.

The good news is that there are many new sources of growth funding available these days. So ask your accountant or trusted advisor and have a good look around to find a strong finance partner.

Banks paying lip service to small business lending

Our MPs 'grilled' the CEOs of the Big Banks recently, with some time spent on small business lending. They focused on just pricing rather than availability and were easily side-stepped. The show goes on. 

We have heard a lot of soundbites this year about Jobs and Growth and the importance of our small businesses in delivering this. Most Australians work for a small business and most new jobs are created in this sector. However, not much has been said about getting hold of the finance to grow.

Over the last 3 years to June 2016, our banks have increased their housing related mortgage books from $1,178 billion to $1,472 billion according to the RBA and APRA. That's another $294 billion dropped into non-productive, dead assets.

Meanwhile, small business lending has increased by a miserable $26 billion, an annual rate of just 3.4%, to $269 billion over the same 3 year period - not 13-15% pa as stated by ANZ's Shayne Elliott.

Since 2013, only 11% of new business lending has gone to small businesses. Most of the $900 billion of loans outstanding to businesses goes to the big end of town.

Our economy needs finance to grow. Alternative finance or fintech is working hard to fill the very large gap but needs much more tangible support to fix the problem. There is much to do to raise awareness but also to establish standards to ensure fairness and transparency. 

Australian Associated Press 4 October 2016

Commonwealth Bank senior executives have defended the interest rates they charge for small business loans, despite them being comparatively higher than they were during the 2008-2009 global financial crisis.

They admitted the bank got the pricing of such loans wrong during the GFC and were not pricing for risk appropriately.

"When the global banking system went through the experience of the global financial crisis, what we all looked at was the fact that appropriately pricing for risk has ceased to occur," CBA boss Ian Narev told the House of Representative economics committee in Canberra on Tuesday.

"Whilst conditions at the moment in terms of defaults are actually reasonably good ... we are safeguarding hundreds of billion Australia's deposit money, we must price for the risk of default over a cycle."

Mr Narev was answering questions from Liberal MP Craig Kelly who couldn't understand why the margin on business loans on average was 5.75 per cent above the RBA rate, and higher than during the GFC when economic circumstances are much improved now.

"There is a view generally because a business loan is secured by a mortgage over someone's home that therefore interest rates should be the same as the home loan, that's just not true," CBA's chief risk officer David Cohen said.

The loans were now more accurately priced given around 40 per cent of new businesses fail in their first couple of years.


The Australian 5 October 2016

Small business losses ‘increasing’

Liberal MP Craig Kelly is questioning the elevated cost of products available to small businesses. Elliott says the bank understands risks associated with small businesses that didn’t exist in the past.

“Losses in small businesses have been increasing, and they are much higher,” he says.

Hodges says banks are increasingly the scale of unsecured loans to small business, understanding many of them don’t have assets.

Elliott says lending to small business is growing at 13-15 per cent each year, but says “a lot of small businesses don’t need debt” and the bank is also helping with small business services.

“It’s not huge but I want it to be bigger. There is a transition happening in the economy ... and we want to be part of that and help those businesses set up,” he says.

“What people want is a really competitive rate, and then they want the right service proposition.”


The Australian 6 October 2016

Chairman David Coleman takes over for the last time.

The Liberal MP is back onto funding costs, forcing Hartzer to risk getting “too technical”. We don’t need that late on a Thursday afternoon.

Coleman wants reasons for the widening gap between small business loan rates relative to mortgage rates.

“It would be fair to say in the past we underestimated the loss rate (for small business loans),” Hartzer says, indicating banks are catching up on the risk differential.

“Small business loans go bad about five times more often than a home loan. And the loss rate is around 10 times. The combination of all those things have fed into that difference.”

The Westpac chief says the gap is around 1 per cent between small business loans and mortgage rates.

“It’s not a massive difference.”

Hartzer then admits small business loans had previously been “uneconomically priced and unsustainable”.

Interest rates: lower for longer. Time to look at P2P investing.

Interesting perspective in the Financial Times on the effects of Brexit. The hunt for yield is likely to intensify. Building a diversified portfolio of Peer-to-Peer loans is a sensible option to consider.


Watch the interest rate outlook shift following Brexit vote

Gillian Tett

Future historians may conclude this is one of the most important ripple effects of the poll

When the results of the UK’s EU referendum emerged last Friday morning, the share price of MetLife, the stolid American insurance group, tumbled. In the course of two days its stock fell 14 per cent, making it one of the worst performers on the American indices.

At first glance, that seems bizarre. MetLife does not sell policies in the UK and its exposure to Europe is small. So it should be shielded from the more obvious potential effects of the vote that are looming over UK companies, eurozone banks and Wall Street giants, such as a European recession or a loss of business and influence for the City of London.

But MetLife has a vulnerability that highlights one impact of Brexit that will have further-reaching consequences. Market actors have turned their attention to the wider outlook for interest rates. Most notably, in recent days, investors have sharply downgraded their expectations for inflation and interest rates, not just in the UK but across the west.

That has nasty implications for asset managers of all stripes, including insurance companies, which need to earn decent returns to pay policyholders. It is also painful for banks, since low rates typically hurt their earnings.

When future historians look back at the Brexit shock, they may conclude that this shifting rate outlook is one of the most important ripple effects of the Leave vote — even if the implications of a Brexit for bond prices look less thrilling than, say, the political soap opera around Boris Johnson, the leading Leave campaigner who has pulled out of the race to be UK prime minister.

To understand this, take a look at the numbers. A couple of years ago negative-yielding bonds — which, in nominal terms, pay less at maturity than investors initially paid — were rare. But this week, Fitch Ratings agency calculated that there is now $11.7tn worth of sovereign debt in the global market that carries negative nominal interest rates.

That is extraordinary. Furthermore, this pile has swelled by $1.3tn in the past month alone, and includes $2.6tn of long-term bonds (those with more than seven years of maturity). Meanwhile, the pile of bonds with a yield that investors used to consider normal — above 2 per cent — is barely worth $2tn.

Most of this negative debt sits in Japan and the eurozone. But rate expectations in the UK and US are sliding, too. The US Treasuries market, for example, now expects a mere 125 basis points of rate rises in the next decade, with barely any hikes in the next two years. Indeed, one of America’s largest hedge funds is now warning its clients that “markets in aggregate are discounting . . . effectively no monetary tightening for a decade across the developed world”.

Can this gloomy market prognosis be believed? Maybe not. After all, the global economy is still growing overall, with lacklustre expansion in the US. A dash to havens may also have influenced some of the recent bond price swings. If the political climate stabilises and the Remain camp’s prediction of economic disaster in Europe turns out to be overblown, the downbeat outlook of the markets could be reversed.

But, there again, it is also possible to draw an even gloomier conclusion: that Brexit has crystallised and intensified more fundamental investor fears that the west is slipping ever-deeper into economic stagnation. After all, that $11.7tn negative-yield bond pile did not just emerge after the referendum but has in fact been swelling for many months.

Either way, the one thing that is clear is that unless that pile suddenly and unexpectedly shrinks, investors and policymakers need to prepare for yet more ripple effects in the months ahead. For one thing, asset managers and insurance companies will see their earnings slide unless they start buying more risky debt — which will bring dangers of its own.

Second, the central banks’ policy dilemma will intensify since they will face pressure to engage in further loosening monetary experiments — even though it is unclear that these unprecedented measures are actually boosting growth.

And there is another nasty twist. Negative, or low, rates may exacerbate income inequality, too, since these typically raise the value of assets that wealthy people own, such as property and stocks. If so, that might create even more political populism, sparking more political uncertainty and economic gloom.

The real ripple effects of Brexit, in other words, may have barely been seen yet. All eyes are on the political polls and trade flows, and on those bond prices.

http://www.ft.com/cms/s/0/63e265c0-3ebd-11e6-9f2c-36b487ebd80a.html#ixzz4D7AZiu00

Have a plan to bridge short term cashflow dips

Every business should have a contingency plan to deal with an unexpected dip in cash flow. While simply having a business overdraft available provides some degree of short-term protection, it’s best to have an array of lifelines at your disposal. Also, we find that the overdraft gets used for everyday purposes rather than for unexpected problems.

Peer-to-peer financing is another clever route to addressing temporary dips in cash flow. Conventional peer-to-peer financing involves online companies lending to businesses from funds gathered through a pool of investors. These loans are usually quicker and more straightforward than conventional borrowing and there is no minimum amount, so they are perfect for topping up cash flow. Beware: some offer much better value than others: don't be taken in by headline rates, do some calculations or check with your accountant.

Another smart take on peer-to-peer financing is an online improvement on invoice ‘factoring’, whereby a business in need of cash sells its ledger to a bank or another conventional lender. The online providers in this area of peer-to-peer financing, which include InvoiceX, will buy (for 1.5-3% per month) individual invoices – allowing companies to easily draw specific, limited amounts – but avoid the hidden fees, long contracts and slow decision processes of traditional factoring providers. For working capital spikes, this is often a better ongoing solution than a short term loan which can cause more cashflow problems a few months later. Importantly, watch out for whether your customer needs to be notified.

Rapid growth in finance options for small-medium sized businesses

Interesting article in The Australian today covering a survey by eBroker which gives insights on the rapid growth in non-bank business lenders.

The question of regulation of business lenders is generally not well understood, we find. As neither an AFSL or credit licence is not required to lend to businesses, you cannot obtain one even if like us you would like one. The same applies to established non-bank lenders like Scottish Pacific. So there’s a bit more to it than APRA. 

In 2008, COAG agreed to a two phase reform process for the regulation of credit and that in Phase Two the Commonwealth would consider the need to change the definition of regulated credit, and to address practices and forms of contracts that were not subject to the Credit Act. After lengthy consultation, on 21 December 2012, the Minister for Financial Services and Superannuation, Bill Shorten, released for public consultation draft legislation to address perceived gaps in existing credit regulation and enforcement. In typical “Yes Minister” style, after many detailed contributions, the consultation was kicked into the long grass because another inquiry, the Financial Systems Inquiry, had started!

With an increasing focus on the problems for SMEs in accessing finance, hopefully this issue will rear its head again as we certainly need some standards to be applied. For example, effective interest rates (APR) which very few seem to understand.

Loans flood in for fintechs

THE AUSTRALIAN

JUNE 22, 2016

 

Michael Bennet

Extract:

Non-bank business lenders are receiving more than $1.1 billion of loan applications every month as awareness of new fintech operators and other alternative providers accelerates, according to a new survey.

Providing insight into the level of demand for loans outside traditional banks, the survey by online business lending aggregator eBroker found non-banks were attracting at least 11,676 loan applications a month, worth $1.13bn.

Non-banks are alternative lenders that don’t take deposits, sidestepping the need for a full banking licence and oversight by the Australian Prudential Regulation Authority.

The survey, conducted with marketing company WebBuzz, took place in early May and included the chief executives of 29 non-bank business lenders, including providers of unsecured cash flow loans, equipment finance, invoice discounting and trade finance.

Know your business credit score and be careful shopping for credit

As explained in a recent article on our blog, new credit reporting laws came into force on 12 March 2014, with major changes in what information can be included on a credit report and how that information can be handled. As a result, credit providers can access much more comprehensive information about you and your business.

There are 3 major suppliers of credit scores in Australia: Veda, Experian and Dunn & Bradstreet. Veda is the most commonly used provider and is now owned by Equifax (US). Veda holds data on more than 16.4 million credit-active individuals, 3.6 million on companies and businesses and 3.4 million on Sole Traders throughout Australia.

Your Veda Business Credit Score is a number ranging from -200 to 1200 that summarises how financially risky your business is. The score tells people how likely you are to pay your debts. The higher your Business Credit Score, the lower the risk of your business. The highest score, 1200 means that there is a 0.1% chance that you won’t pay all of your bills in full and on time over the next 12 months. The lowest score -200 means that there is a 94.1% chance that you won’t pay all of your bills in full and on time over the next 12 months.

When you apply for a Business Loan, lenders will use your Business Credit Score as one of their checks to determine whether to lend to your business. This is one of the quickest and most common checks a lender makes, so it is important for you to understand your score and improve it if necessary.

Veda uses complex algorithms and hundreds of data points to build up your Business Credit Score. These include whether you have paid your bills on time, how often you have applied for loans and in what space of time, the types and amounts of loans you have applied for, who the directors of your business are, and how long you have been in business, to name a few. The most important factor in your score is whether you have paid your bills in full and on time.

Anytime you apply for a loan, the lender will look at your credit report to see whether you have repaid your debts in the past. The more you shop for credit, the more this adversely affects your credit score. This is not generally understood by most business owners.

Therefore, it is wise to be careful about who you approach for finance. It is usually a good idea to speak to a well informed broker.