SME finance

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  • Banks have effectively withdrawn from their original purpose: facilitate commerce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 
 

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.

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.

Invoice trading is booming in Australia, according to a report by KMPG, University of Sydney, Cambridge University and Tsinghua Graduate School

As reported in The Australian today, in the first Asia-Pacific report surveying Alternative Finance published this week, it is notable that, relative to consumer lending, alternative business finance and, in particular invoice trading, has developed much more strongly in Australia than in the US and the UK.

We are quoted in the article as noting that this underlines the exceptionally under-served nature of the Australian small business lending market, which at the recent Altfi Summit in Sydney was estimated to be seeking an additional $95bn of finance.

This trend is also reflected in RBA lending statistics which show property loans since the GFC have grown by $538.7bn (+54%) while business lending has increased by just $72.5bn (+9%).

(RBA Statistics: Business Credit Seasonally Adjusted: $765.5bn in December 2008 to $838.0bn; Housing Credit (Owner Occupied and Investor) $992.9bn to $1,531.6bn)

KPMG’s endorsement of invoice trading will go a long way, but regulation is what really builds trust in a sector. The truth is, unlike consumer lending, a sandbox won’t accelerate the development of innovative new business finance products – but increased involvement from and endorsement by the gamekeeper will accelerate business adoption.

The government’s most pressing need now is to accelerate the adoption of alternative finance by SMEs, which would provide a kick-start to our economic growth. Introducing disclosure standards as to the cost of finance and terms and conditions of finance – similar to comparison rates for mortgages – is a simple step to take, but would dramatically change the reputation of the sector.

It’s clear that the regulatory environment needs a 21st century approach, and the government seems to be aware of this, but we are all waiting to see words turn into action. We’re in a similar position to when the SMSF market first emerged – the regulators had to rapidly come up with a new approach then, and the need is even more pressing now with the increased speed of the development of new business finance products.

As Paul Keating said: “When we laid the foundations for the current superannuation system in the 1991 Budget, I never expected Self Managed Super Funds (SMSFs) to become the largest segment of super. They were almost an afterthought added to the legislation as a replacement for defined benefit schemes.” 

Time to get wriggle on!

  

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Why Government needs to get involved in fixing business lending

Interesting views from a notable economist, Joseph Stiglizt, in promoting his book, Freefall: 

I believe that markets lie at the heart of every successful economy but that markets do not work well on their own. In this sense, I'm in the tradition of the celebrated British economist John Maynard Keynes, whose influence towers over the study of modern economics.

Government needs to play a role, and not just in rescuing the economy when markets fail and in regulating markets to prevent the kinds of failures we have just experienced. Economies need a balance between the role of markets and the role of government – with important contributions by non-market and non-governmental institutions. In the last 25 years, America lost that balance, and it pushed its unbalanced perspective on countries around the world.

We should take this moment as one of reckoning and reflection, of thinking about what kind of society we would like to have, and ask ourselves: are we creating an economy that is helping us achieve those aspirations?

We now have the opportunity to create a new financial system that will do what human beings need a financial system to do; to create a new economic system that will create meaningful jobs, decent work for all those who want it, one in which the divide between the 'haves' and 'have-nots' is narrowing, rather than widening; and, most importantly of all, to create a new society in which each individual is able to fulfill his aspirations and live up to his potential, in which we have created citizens who live up to shared ideals and values, in which we have created a community that treats our planet with the respect that in the long run it will surely demand. These are the opportunities. The real danger now is that we will not seize them. 

 

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2 actions that Government can take to accelerate business growth

Yesterday, Australia saw the establishment of a government advisory panel on Fintech and the launch of a reform manifesto by Fintech Australia which we support.

We strongly believe that Government needs to become bolder in addressing market failure in providing our small-mid sized businesses with access to growth capital.

Here are two steps that could be taken this year:

  1. Build awareness of alternative financing options for SMEs to address market failure
    eg a mandatory referral obligation for banks declining credit applications
     
  2. Set up a Business Bank to: 
    • consolidate existing government funding mechanisms for SMEs in one place; and
    • provide modest co-investment support and endorsement for Alternative Finance providers

Working capital is the main impediment to growth, not equity.

Service businesses need working capital to grow and the current Basel III banking system cannot help in a meaningful way.

This is particularly true in the case of our critically important mid-sized companies:

Grant Thornton, December 2015:

According to the firm, mid-size business injects a combined annual turnover of $1.1 trillion into the Australia economy; contributing a further $241 billion through wages and salaries, employing more than 3.7 million Australians in the process.

Background

There are interesting overseas examples, particularly in the UK.

ACCESS TO FINANCE - FREE UP ALTERNATIVE FINANCE

The UK's major lenders will soon be required to share the financial information that they keep on small business to give these companies the best chance of securing loans.

The Government plans to force the banks to share their SME credit information with other lenders and to offer to share the details of SMEs rejected for a loan with online platforms that can match them to alternative finance providers.

The British Business Bank has also been tasked with "increasing and diversifying" the supply of finance available to SMEs. The Bank will facilitate up to £10bn of finance by 2019, according to new forecasts.

 

 

CONTEXT - MARCH 2014

At present the largest four banks in the UK account for over 80% of UK SMEs’ main banking relationships. Many SMEs only approach the largest banks when seeking finance. Although a large number of these applications are rejected - in the case of first time SME borrowers the rejection rate is around 50% - a proportion of these are viable and are rejected simply because they don’t meet the risk profiles of the largest banks. There are often challenger banks and alternative finance providers with different business models that may be willing to lend to these SMEs.

Although the largest banks will sometimes refer these SMEs on (e.g. to brokers), in many cases challenger banks and other providers of finance are unable to offer finance as they are not aware of their existence and the SMEs are not aware of the existence of these alternative sources of finance. This is a market failure, of imperfect information, resulting in SMEs that are viable loan propositions not receiving the finance they need.

Why is invoice trading so different from conventional debtor finance?

We enjoyed reading a very useful article on Altfi recently which highlighted the leading invoice finance platforms in Australia.

Some important differences were highlighted:

First and foremost, it’s crucial to state the difference between invoice financing and invoice factoring, as they aren’t the same thing at all.

The former refers to borrowing money against businesses’ outstanding accounts receivables. An example helps to clarify the point. A lender gives entrepreneurs cash today in relation to the value of the company’s accounts receivables – money owed to the firm, which clients will pay in the future (hopefully). Once the clients pay up, entrepreneurs then repay the lender the amount loaned plus fees and interest.

The latter is a bit different. Indeed, in this case the lender “buys” the accounts receivables entrepreneurs are owed and takes over collecting from the clients. With invoice factoring, the lender will pay the business owner a percentage of the total outstanding invoice amount, then takes responsibility for collecting the full amount. Once they collect the full amount, they’ll advance entrepreneurs the difference, keeping a percentage for their services.

The main difference between these two forms of financing is obvious. In the first case, the business owner is still responsible for collecting outstanding money owed by his/her clients. In the second case, clients will deal with the factoring company to make their payment, not the business owner.

This usefully sets out some key foundations based on conventional debtor finance. During the early 1990s, 'invoice financing' or 'discounting' as described above developed into a major asset finance product for larger companies. In recent years, banks have steadily withdrawn from this segment due to the inherent risks and operational complexities.

Invoice finance is now seeing the development of a next generation product: confidential invoice trading. Over $2 billion of finance has been provided in this form in the UK alone, having started only 5 years ago.

This is a revolutionary new way of doing invoice finance, as pioneered by Marketinvoice in the UK since 2011 and adapted by InvoiceX for the Australian market since 2014. 

Confidential invoice trading opens up a broad market of high quality, growing businesses who are attracted to raising flexible growth capital confidentially on attractive terms. These companies are not attracted to factoring or invoice discounting.

  • Unlike factoring, our invoice trading solution is confidential. We are the only platform that offers this in Australia. We do not contact or chase the debtor for payment.
     
  • Unlike invoice discounting, our investors own the traded invoice. This is a much better place to be from a credit risk perspective. Our investors are not materially exposed to insolvency risk from the seller. Therefore, we can offer much better terms to SMEs and much larger facilities.

We are very excited as this form of finance opens up so many growth opportunities for many of Australia's most promising companies.

Why is invoice trading the smart way to grow and who offers it in Australia?

Great to see real progress this year in raising awareness of invoice trading. We operate the only confidential invoice trading platform in Australia. Our growing business customers love using our service and our investors are happy. That makes us happy too!

Spotlight On The Top 5 Australian Invoice Financing Platforms
By Guglielmo de Stefano on 18th February 2016
 

In a recent article, AltFi investigated what’s happening in the Alternative Finance Market in Australia. What emerged is that the AltFi revolution seems to have started approximately when Matt Symons and Greg Symons founded SocietyOne in 2012, the first fully compliant peer-to-peer lending business in the country.

That research focused mainly on peer-to-peer lending and equity crowdfunding. Although these two subsectors are key pillars of the broader alternative finance spectrum, we believe that invoice financing also deserves the same attention.

First and foremost, it’s crucial to state the difference between invoice financing and invoice factoring, as they aren’t the same thing at all.

The former refers to borrowing money against businesses’ outstanding accounts receivables. An example helps to clarify the point. A lender gives entrepreneurs cash today in relation to the value of the company’s accounts receivables – money owed to the firm, which clients will pay in the future (hopefully). Once the clients pay up, entrepreneurs then repay the lender the amount loaned plus fees and interest.

The latter is a bit different. Indeed, in this case the lender “buys” the accounts receivables entrepreneurs are owed and takes over collecting from the clients. With invoice factoring, the lender will pay the business owner a percentage of the total outstanding invoice amount, then takes responsibility for collecting the full amount. Once they collect the full amount, they’ll advance entrepreneurs the difference, keeping a percentage for their services.

The main difference between these two forms of financing is obvious. In the first case, the business owner is still responsible for collecting outstanding money owed by his/her clients. In the second case, clients will deal with the factoring company to make their payment, not the business owner.

In Australia, from what we can establish, the top 5 Australian invoice financing/factoring platforms are Waddle, Marketlend, Timelio, FundX and InvoiceX.

Waddle: Founded in July 2015 by Leigh Dunsford and Simon Creighton – owners of invoice factoring company Trade Advance – Waddle is an invoice financing platform, which has provided about 20 Australian SMEs with approximately $1 million in financing to date. In a recent interview, Leigh was keen to highlight that Waddle is no ordinary invoice factoring company. The platform offers a solution similar to factoring in some ways, but very different in others. As with factoring, Waddle provides funding against small businesses’ outstanding invoices. Unlike factoring solutions, businesses’ clients are never contacted or hassled by Waddle and entrepreneurs are able to skip on the paperwork headaches that historically plague the factoring process. 

Marketlend: Founded in December 2014 by Leo Tyndall and Paul Roffey, Marketlend was conceived as a business peer-to-peer lender, offering loans to businesses in the form of working capital, traditional business loans and commercial property finance. Its offering includes three products: a debtor finance product, an invoice financing solution and a trade finance service. In the case of invoice financing, loans are secured by a personal property interest over the borrower’s company and the platform owns the supplies as it pays for them; in the case of the debtor finance offering, they are secured against the borrower’s accounts receivable. To find out more about Marketlend click here.

FundX: Based in Sydney, FundX was founded by David Jackson – former Australian small business builder and investor. According to him, the primary aim of the company is to connect businesses with investors who can fund their cash flows. Users are provided rapid access to funds based on the value of their outstanding invoices. FundX uses big data, machine learning and predictive algorithms to analyse risk and authorise invoice funding “with the push of a button, in less than a minute”. 

InvoiceX: Founded by Dermot Crean and Steve Yannarakis, the company is strongly placed to help small and medium enterprises (regardless of their business sector) to deal with working capital pressures. Its primary product – the Match Maker Trading Platform – rapidly matches investors with businesses, optimising the deal for both parties. InvoiceX assures the total absence of set-up fees and a straightforward application process. The company aims to provide a cash advance – up to 85% of the Face Value of an invoice – within 24 hours.

Timelio: Founded in 2014, Timelio – formerly known as InvoiceBid – enables businesses to raise short-term finance by selling their unpaid invoices directly to a network of investors. The platform requires investors to fund their accounts with a minimum of $25k. Before being approved to sell invoices on the platform, all invoice sellers undergo a rigorous credit assessment. The platform states that third party analytics and searches might be used to further support the internal assessment. Before being made available for investment, each invoice and debtor will be verified and authenticated. Timelio has been recently awarded the “Game Changer of the Year Award” sponsored by Visa and the “Overall Award for Outstanding Excellence” sponsored by Optus at the OPTUS My Business Awards in Sydney. 

If you want to know more about the alternative finance space in Australasia, be sure to book your tickets for the AltFi Australasia Summit 2016 before they sell out.

Basel Committee's new approach: banks will turn further away from SME lending

The Basel Committee released its second consultative document on Revisions to the Standardised Approach for credit risk in December (comments due by 11 March 2016).

There has been little or no commentary about its impact on SME lending - we believe that the effects will be far reaching.  

The committee pulled back from the penal ‘negative equity =>150% risk weighting’ approach that was previously proposed. Now they propose a general 85% risk weighting. This compares with a current 60% weighting so is still bad news for SMEs looking to raise finance from banks.

There are statements in the document about having to apply 100% risk weighting if due diligence requires it. The proposed revision to lease accounting (IFRS 16) could be a factor here.

So the future of SME lending remains in a state of flux, with the 'Big 4' IRB version yet to be released. The outcome is likely to have a major impact on SME lending by banks, especially as it affects mid-sized businesses that drive growth and jobs across Australia.

SMEs now only represent 15% of new business lending by banks and outstanding loans have fallen to 30% of all business lending (early ‘90s – 50%).

It is already quite uneconomic for banks to lend to SMEs and becoming more so. We believe that this downward trend is set to continue, as is happening globally.

Little attention is being paid to the baby boomer business exit tsunami in Australia

A very interesting read. The conclusion is spot-on:

A significant opportunity to consider the issue at a government level appears to have been lost. If the factors leading to the baby boomer business exit tsunami are not adequately addressed, it’s likely to put a solid dent in Australia’s aspirations to be an agile, innovative and competitive economy.

There's an elephant in the room!

February 18, 2016

We have all experienced the “elephant in the room”: the big problem in the corner no one wants to talk about because it’s way too complicated or difficult. Everyone just hopes it will go away.

There is another sort of elephant in the room though, a far more insidious one, the “invisible elephant”: the big problem no-one has properly identified.

We have a big invisible elephant issue looming in the private business sector. It’s called the “baby boomer business exit tsunami”.

Here are the scary facts:

  • Up to 80% of private businesses in developed economies are owned by baby boomers. The Australian private business sector is estimated to be worth well in excess of $1.5 trillion, so baby boomer business owners currently own businesses collectively worth hundreds of billions of dollars.
  • The last of the baby boomers turned 50 last year, so the baby boomer generation is well and truly heading towards retirement. Most baby boomer business owners plan to exit their business over the next 10 to 15 years.
  • Fewer private business owners are planning to pass their business on to the next generation. In 2012, 38% planned to do so. It’s now dropped below 25%.
  • More than 70% of private business owners have no business exit or succession plan.
  • Most private business owners aren’t exit ready (ie their business isn’t in good enough shape to sell, even if they did receive an unexpected offer from a potential purchaser).
  • Anecdotal feedback from business brokers suggests that, at best, only three to four businesses in 10 they see are in a condition to be sold.
  • Good business exits and succession arrangements take far longer to complete than most business owners realize (often a number of years).

While time will tell exactly how the baby boomer business exit tsunami plays itself out, it’s likely to look something like this:

As baby boomer business owners reach retirement age and look to exit their businesses, it will lead to many more businesses hitting the market place than usual in a relatively short period of time.

The number of businesses being passed to the next generation has been steadily declining for some time.  Fewer children are interested in taking over family businesses; those who are entrepreneurially minded often prefer to start their own.

The flow on consequence is more buyers will be required to buy the increased number of businesses available for purchase.  It’s unlikely there will be sufficient buyers at various times to satisfy the level of selling demand.


As a result, many private business owners will be faced with the prospect of selling their business for a substantially lower amount than they want or, in many cases, won’t be able to sell their business at all.

If you’re a baby boomer business owner, the above scenario looks pretty bleak. However, the baby boomer business exit tsunami also has much wider implications.

The private business sector is often rightly described as the “engine‑room of our economy”. As the Turnbull government’s recent Innovation Statement highlighted, it is critical for Australia to ensure our businesses are, and continue to be, competitive, innovative and efficient to ensure we have a productive and resilient economy.

If the factors leading to the baby boomer business exit tsunami are not adequately addressed, it will inevitably have significant implications for Australian business and the Australian community generally.

In particular, it’s likely to lead to a higher level of businesses closing or failing than would normally be the case.  This will inevitably lead to:

  • job losses;
  • a lessening of competition in various markets;
  • the loss of innovation associated with failed or closed businesses;
  • the inability of many private business owners to adequately fund their retirements (which will effectively move the financial burden back to government);
  • a decline in key services in some sectors (such as professional advisory and health services, in which a disproportionately high level of smaller businesses are owned by baby boomers); and
  • a decline in a range of business sectors in rural and regional areas (where again, many smaller businesses are owned by baby boomers).

So, surely government is across the baby boomer business exit tsunami issue and are looking at ways to deal with it? Well, actually, they’re not.

Apart from a handful of good private sector research projects on the issue, and in contrast to developments overseas, there has been little attention paid to the baby boomer business exit tsunami in Australia.

There was an excellent opportunity for the issue to be comprehensively examined in the Productivity Commission’s somewhat oddly titled Inquiry into Business Set-up, Transfer and Closure. The Inquiry, announced in late 2104 by then Treasurer, Joe Hockey, and then Minister for Small Business, Bruce Billson, was aimed at improving “Australia’s productivity performance by encouraging entrepreneurship, innovation and increased efficiency of Australian business” and “giving small business every opportunity to build upon their role as the engine-room of the Australian economy”.

Given the importance to the Australian economy and society generally of transferring ownership of baby boomer businesses to new ownership in an effective way, it seems odd that the Commission paid so little attention to the issue in its large final Inquiry report. Even more strangely, the Commission virtually made only one, quite vague, recommendation on the issue of business transfer. In essence, the Commission said business exits were largely a commercial matter and government should, at most, only provide general guidelines on business exits to the market place.

A significant opportunity to consider the issue at a government level appears to have been lost. If the factors leading to the baby boomer business exit tsunami are not adequately addressed, it’s likely to put a solid dent in Australia’s aspirations to be an agile, innovative and competitive economy.

Here's a link to an interesting  report: Succession Reset

Lending money is easy. Lending money well is much harder.

Wise words from the CEO of a leading UK P2P lender in an interesting article by David Stevenson for Altfi:

But for me the most important point came in a comment from LendInvest’s boss Christian Faes following the announcement of his excellent results. 

Christian observed that “the world of P2P is a slightly bizarre one in that there’s a lot of talk about how much platforms are lending. But for the industry to mature, investors should start looking at how viable underlying business models are, rather than simply how much a platform has lent. 

Lending money is easy. Lending money well is much harder. 

At LendInvest we are lending substantial volumes but, more crucially, we are a profitable business without having to rely on external funding to stay alive.” 

And what’s true of alternative finance is also true of virtually any disruptive business sector transformed by technology. Bet on profitable businesses with sound business franchises where the revenue lines are transparent and obvious.

 

CBA - why has non-mining capex not picked up? No reference to obstacles in raising finance to grow

For the past few years, economists and policymakers have assumed that a lift in non-mining business investment was forthcoming. A trawl through RBA documents and speeches shows that policy officials have been anticipating a lift in non-mining investment for a few years. And yet despite incredibly low interest rates and a significantly lower AUD, the lift remains elusive. It has felt a lot like waiting for Godot. Fortunately, however, there has been a greater than expected pickup in services activity which has generated a fall in the unemployment rate despite weak non-mining capex. This has supported the economy and employment growth over the past two years. But for the productive capacity of the economy to lift over the longer term, a lift in business investment outside of the resources sector.

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In this note we ask the question why non-mining business investment has been so weak.

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…it may be the case that expectations of future demand are too low to justify a lift in investment…

Capacity utilisation, as measured in the NAB Business survey, implies that throughout most of the past few years capacity utilisation in Australia has been below its long run average. This goes some way to explaining why business investment has been weak. And also why inflation has been low…

Australia’s manufacturing industry suffered greatly because of the first and second stages of the mining boom…

The problem, of course, for the manufacturing sector is that when the currency depreciates to more ‘normal’ levels, it’s not that easy to crank up manufacturing investment and output… the high fixed cost component of manufacturing means for firms that are forced to close, recommencing operations is often not an option…

[ScreenHunter_11560 Feb. 17 10.56]http://www.macrobusiness.com.au/2016/02/the-illusive-future-boom-in-non-mining-investment/screenhunter_11560-feb-17-10-56/

The hurdle rate is too high. Firms generally use Discounted Cash Flow (DCF) analysis (or a version of it) to estimate the attractiveness of discretionary capital investment. But a range of evidence indicates that hurdle rates are often much higher than the weighted average cost of capital (WACC)…

The ‘stickiness’ of business hurdle rates is in stark contracts to valuation methods employed by property investors…The fall in borrowing rates over the past few years gave rise to a big increase in investor activity in the housing market. Dwelling prices rose quite sharply as interest rates fell…

[ScreenHunter_11561 Feb. 17 10.59]http://www.macrobusiness.com.au/2016/02/the-illusive-future-boom-in-non-mining-investment/screenhunter_11561-feb-17-10-59/

Monetary policy has been overburdened for too long… Indeed, record low interest rates have been assumed to be the panacea to get non-mining investment going. But monetary policy can only do so much. The interest rate lever can help smooth out the business cycle. But it cannot do anything to change the more entrenched and structural impediments to growth which are primarily related to the inefficient allocation of resources.

In Australia, for example, policies should be developed that encourage and channel capital into projects that improve the productive capacity of the economy over the long run. Establishing an efficient taxation system that incentivises innovation and productive investment is one area that could help lift business investment…

Public infrastructure investment is also important. For example, greater investment in transport infrastructure will improve the productive capacity of the economy. And it supports private investment rather than crowding it out. At a time when the yield curve is at historic lows, there must be no shortage of viable projects where the costs of finance is less than the social rate of return…

[ScreenHunter_11562 Feb. 17 11.02]http://www.macrobusiness.com.au/2016/02/the-illusive-future-boom-in-non-mining-investment/screenhunter_11562-feb-17-11-02/

Australian investors love dividends! And the pressure on companies to maintain or lift dividends in a low interest rate environment has intensified because deposit rates are so low. There is a risk that the pressure on companies to increase dividends has been paid for by cutting back on capital investment…

[ScreenHunter_11563 Feb. 17 11.03]http://www.macrobusiness.com.au/2016/02/the-illusive-future-boom-in-non-mining-investment/screenhunter_11563-feb-17-11-03/

What can we expect in 2016?.. the leading indicators suggest that non-mining business investment growth is likely to remain weak over 2016. The latest capex survey suggested that non-mining capex would fall over 2015/16… [although] there are limitations with the capex survey…

Notwithstanding the soft capex survey, the latest credit aggregates offer a glimmer of hope on the outlook for non-mining investment. Business credit growth has been lifting which is an early sign of a lift in capital expenditure…

Grant Thornton leads calls for mid-size business minister - we totally agree. Critical driver of growth.

Good article in Accountants Daily. We think this sector deserves special attention, particularly given the declining appetite of banks to lend to businesses. We write about this subject a great deal and will keep writing!

The government can support the growth of its most powerful sector; Australian mid-size business, by establishing a Minister for Mid-Sized Business, according to the CEO of prominent mid-tier firm Grant Thornton.

Greg Keith, Grant Thornton Australia CEO, has led the push for the establishment of a Minister for Mid-Size Business in an attempt to bolster the middle market.

According to the firm, mid-size business injects a combined annual turnover of $1.1 trillion into the Australia economy; contributing a further $241 billion through wages and salaries, employing more than 3.7 million Australians in the process.

“As the engine room of our economy, we urge the Turnbull Government to incentivise mid-sized business. It’s time to appoint a Minister dedicated to fostering the growth needs of the sector and in turn boosting revenue growth for the Australian economy,” Mr Keith said.

“Despite their importance to the economy, mid-sized businesses are under-represented in the national debate. A Mid-Sized Business Minister is needed to develop specific incentive schemes to encourage growth and confidence where it will have the greatest impact,” he added.

Mr Keith also urged the government to establish a Strategic Development Fund, in the hopes of assisting mid-size business to break into the Asia Pacific market.
“This is an important initiative to encourage mid-size businesses to seek new revenue opportunities,” said Mr Keith.

In addition to initiatives to drive forward the mid-sized agenda, Mr Keith suggested that the concessions implemented for small business should be echoed for their mid-sized counterparts; such as a reduction in the company tax rate to 28.5 per cent and the immediate write off of new assets up to $20,000.”

“We would also like to see the Government extend some of its small business incentives to the more developed – and more likely to succeed – mid-size businesses, by extending the concessions to currently provided only to small companies.”

Why is funding for small businesses so severely constrained?

Most small businesses turn to bank financing to fund their operations. However, lending by banks is often limited because understanding small businesses requires more time and expertise than the more standardized consumer business.

At the same time, the traditional relationship-based corporate banking model is costly to operate in dealing with small business, given the smaller loan size. Further, information asymmetry as a result of the lack of supporting financial information infrastructure limits the ability to lend. Small businesses often lack the required data, such as a history of audited statements for a bank to appropriately assess its cash flow situation.

More generally, the high intrinsic risk of SMEs often exceeds banks’ risk appetite. This hesitation is further amplified by regulation, such as Basel III, which imposes higher capital requirements for (riskier) small business loans, compared to loans extended to states or home owners.

Over past years, banks have thus further decreased their lending exposure to SMEs while the costs of borrowing have increased for SMEs. In the US, SME loans as a percentage of all bank business loans fell from 35% to 24%. In the Eurozone, borrowing costs for SMEs as spread over larger loans increased by 150%.

The Future of FinTech: A Paradigm Shift in Small Business Finance, October 2015

Business ownership is becoming less common at younger ages - could it be a funding problem?

The Productivity Commission's recent report on Business Set-up, Transfer and Closure included the following disappointing finding:

The proportion of those aged 25‑34 who owned a business declined between 2006 (8 per cent) and 2011 (7 per cent). The largest proportional decline in business ownership was for those aged 35‑44, while business ownership increased for those over 65.


It is widely acknowledged that the Australian population is ageing (PC 2013a; Commonwealth of Australia 2015) and similar ageing trends have been observed for business owners. The average age of Australian business owners has increased (by one year between 2006 and 2011) to 47 years, in comparison to the broader workforce where the average age of 40 years has remained unchanged over the same period. Nearly 10 per cent of business owners are now beyond the traditional retirement age of 65 and another 20 per cent are within 10 years of the retirement age. 

The Australian Government asked the Productivity Commission to undertake a public inquiry into barriers to setting up, transferring and closing a business and identify options for reducing barriers where appropriate. The inquiry report was handed to the Australian Government on 30 September 2015 and publicly released on 7 December 2015. It deals with the key drivers of business set-ups, transfers and closures.

Why SME lending doesn't make sense for our banks, according to the RBA

It's time that our banks started to be upfront about lending to small businesses. It doesn't make any sense for them and they only do it to access cheap deposits.

The Reserve Bank of Australia issued an interesting report in October 2015, the main focus being on leveling the playing field in residential mortgages between the Big 5 banks and the smaller ones.

However, it also succinctly highlighted why SME lending is so unattractive for our banks. They need 4 times more of their own capital to lend to a small business than the amount required to advance a residential mortgage loan. Add in the costs of dealing with the complexity of business lending and it is clear why it is such an unattractive business for them.

And with the looming regulatory capital changes ahead, SME lending is going to become a lot less attractive: up to 10 times less in fact.

Thankfully, the Alternative Finance market is now developing but, if not actively supported by our policy-makers,  it will take too much time to plug the gap that really needs filling now, not in 5 years time.

Let's hope Canberra is on to this.

 

SME finance in Australia is changing for the better thanks to P2P/marketplace lending

Oz P2P Lender Releases Loan Book

By Guglielmo de Stefano on 2nd February 2016
 

Invoice trading platform InvoiceX publishes its loan book as part of its plan to boost transparency.

Australian online invoice trading platform InvoiceX today announced the publication of its loan book, containing tons of data on more than $6.5 million of invoice trades from November 20th 2014 – when the platform launched – to 31 December 2015. According to the data, the company is on track to trade over $50 million worth of invoices in 2016.

Founded by Dermot Crean and Steve Yannarakis, the company is strongly placed to help small and medium enterprises (regardless of their business sector) to deal with working capital pressures. Its primary product – the Match Maker Trading Platform – rapidly matches investors with businesses, optimising the deal for both parties. InvoiceX assures the total absence of set-up fees and a straightforward application process. The company aims to provide a cash advance – up to 85% of the Face Value of an invoice – within 24 hours.

Dermot Crean, co-founder and director of InvoiceX, commented:

“Greater transparency is key to taking P2P lending mainstream, both for businesses and consumer loans. It is our hope that release of this data will prompt other P2P lenders to take the same action. We want to ensure that all business owners in Australia who are eager to grow have access to transparent and fair finance which puts the rights of borrowers at the centre of the lending process.”

Since inception, InvoiceX has facilitated 201 trades for SMEs with an average trade face value of $33,098, an average discount fee of 1.2 per cent per calendar month and an average settlement period of 35 days. The platform is keen on highlighting the differences between its business model and a normal factoring provider. Traditional factoring involves long lock-in periods, much higher costs and the losing of control of sales ledgers and collections. Conversely, InvoiceX’s product is totally confidential, with no lock-ins and a good deal of flexibility.

According to Dermot, the release of this data is indicative of a maturing P2P lending market in Australia. He said:

“The public release of this lending data will allow businesses to make easy comparisons between P2P lenders, and also directly with traditional finance options such as term loans and mortgages. […] Greater transparency is key to taking P2P lending mainstream, both for businesses and consumer loans. It is our hope that release of this data will prompt other P2P lenders to take the same action.”

It’s widely acknowledged that transparency is a key pillar of the Alternative Finance Space – essential to ensuring the sustainable growth of the asset class and to demonstrating that alternative finance platforms are behaving responsibly.

InvoiceX claims to be the first P2P Australasian platform to publish its loan book. “It's great to be the first to do this ever in Australian SME finance,” said Dermot. RateSetter Australia, following in the footsteps of its UK-based progenitor, uploaded its complete loan book online last October – although this resource is updated on a quarterly basis. On a global scale, many players have already disclosed their data, including the likes of ZopaFunding CircleRateSetter and MarketInvoice in the UK.

Aside from increasing the public’s opinion of the sector, data is critical also from a practical perspective, allowing for the construction of indices, such as the The Liberum AltFi Returns Index (LARI), which will likely come to form an essential component in the maturation of the sector.

AltFi Data today added an Australasian section to its Resources page, providing a link to the InvoiceX loan book, which is accessible here. We suspect that InvoiceX may have company in the Australasian section before long.

End of SME business banking as we know it

Currently, banks are required to allocated 4 times more of their own shareholders' capital against Small Business Loans than required for residential mortgages.

As bank management teams focus on maximising Return on Equity (RoE), this makes it hard for banks to justify lending to small businesses. However, it's acceptable as long as they receive more in the way of cheap deposits from other small businesses.

Now the regulators are discussing increasing the amount of capital that banks must set aside against Small Business Loans - it could be 5 times more than the current requirement (300% risk weighting versus about 60% currently). This looks like the end of Small Business Banking as we know it.

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These proposals would apply to smaller banks that are required to apply the Standardised Approach. We await the proposals for major banks but expect a similar approach.