There has been a lot of noise recently about credit tightening in the residential market as a result of the ever-changing landscape of bank lending policy and what will happen to the “property bubble”. However, the fallout is not limited to just property investors - the corporate lending market will also soon be feeling the squeeze as the Australian Prudential Regulation Authority casts a wide net in enforcing tough new rules.
Top-tier banks are now demanding more onerous reporting of earnings before interest, tax, depreciation and amortization (EBITDA) from business owners applying for loans, along with enforcing greater income to loan ratios based off these EBITDA guidelines. They are also demanding stronger tangible asset balance sheets, longer trading histories and greater cash trading surpluses.
New restrictions particularly affect businesses wanting sub $30 million loans, where there were already only a handful of major bank players. This has effectively paved the way for a ‘one horse race’, where lenders can reject or accept applications from stable businesses due to their appetite for that deal at that time.
In this environment, it’s dangerous for any borrower to rely on top-tier funding. Major banks themselves are imposing strict loan terms not only on corporate lending, but also on business property lending.
The CBA in particular has adopted a practice of demanding quarterly or even monthly reporting to track debt to income ratios as a loan condition. If the ratios are not met, the Bank still has the power to default, regardless of whether loan repayments are being made
A majority of borrowers are not meeting these stricter conditions and are being left with very few financing options. As a result, many proven but junior asset backed borrowers with strong business models are being forced to look to second-tier lenders, where loan conditions are heavily skewed towards higher income levels above higher interest rates.
Effective rates with these second-tier lenders (including application and ongoing management fees) end up being higher than those for personal credit cards. Essentially, missing out on loans from top-tier banks means a rise in the effective cost of capital from around 5.5 per cent to 20 per cent.
Given the recent tightening of the major banks on corporate lending, the only alternative for borrowers is to turn to second tier lenders.
The flow on effect from this will be a burgeoning second-tier loan market where private equity takes on what has traditionally been the small-to-medium enterprise banking space.
Unfortunately, things are going to get a lot worse before they get better. It is up to the government to level out the market by increasing competition in this vacuum between top banks and second-tier lenders.
Government reform should include policy changes and funding to allow licensed professionals to access this market to compete with second-tier lenders. Otherwise, financiers in the second-tier will monopolise the market, with greater opportunity to manipulate term sheets so that they give rise to technical events of default.
The long term effects could be destabilising for a huge part of the business sector unless the government steps in to offer new and practical options for corporate lending and business property lending.
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